BofA's 'Critical Stress Signal' Was Just Triggered: "This Is Where Central Banks Step In"

The last two hours of trading on Friday aside, when a violent short squeeze coupled with unsubstantiated speculation by JPMorgan that the quant deleveraging and selling is finally over send the Dow Jones soaring over 600 points in under an hour, the stock market remains especially volatile and vulnerable to even the smallest shifts in sentiment.

Meanwhile, as Bank of America's derivatives team writes, the bank's proprietary Critical Stress Signal (CSS) was triggered to "Risk-off" on 8-Feb-18, with 13 components rising by more than 0.5 standard deviations in a 10-day period.

Looking at the internals of the index, it's a familiar story: there was an eruption in equity vol which promptly cascaded across stock markets, while keeping other asset classes relatively insulated. However, as we showed over the past two days, there have been distinct instances of contagion from stocks to credit, rates, FX and even commodities, and as equity vol is sliding, X-asset vol continues to rise.

From BofA's perspective, equity skew, or the price of equity tail protection, and the shock to US equity vol this week, were the real stress outliers...

... but it was a follow-on from FX and credit risks in recent days that tipped the signal into risk-off territory.

Further to the lack of a broader market selloff, while concerns over rates risks are the common narrative, the stress in rates components have remained relatively subdued thus far.

However, as BofA notes, further instability in rates and credit, along with CB reactions to this stress remain key to monitor, in our view.

  • The good news: the more isolated the risk remains within equity, the more easily we expect it will reverse.
  • The bad news: the lack of a response is due to investor expectations that should conditions deteriorate, central banks will step in.

Which bring us to the punchline of the BofA report: according to BofA strategists, the CSS was designed to identify tipping points in cross-asset risk – "the point at which stress momentum keeps building and risk-assets suffer."

Paradoxically, beginning in 2013 with the taper tantrum, the Critical Stress Signal has been a remarkable contrarian indicator, as it has closely aligned with the timing of central banks either verbally or physically intervening to calm markets. 

In other words, the worse things got for the market, the greater the likelihood that central banks step in and support it. Or, as Michael Hartnett puts it, "markets stop panicking the moment central banks start panicking." As seen in the chart below, this very moment is when one or more central banks should reassure the market that all shall be well.

It also explains the violent BTFD moments at the tail end of any selloff as algos and human traders scrambled to frontrun central bank intervention following a market selloff, creating a self-fulfilling prophecy of market rebounds which no longer needed central banks to bail them out: the mere precedent was sufficient.

The problem - for investors - is that the precedent may no longer be sufficient as policy intentions are now far more nebulous when it comes to the probability of an imminent central bank intervention, either verbal or physical. As BofA admits, "since the last stress signal in 2016, rates and inflation expectations have increased, we have a new Fed chair, and CB rhetoric appears more hawkish, creating uncertainty over where the “CB put” strike sits today."

And that's the $6.4 trillion question: at what level - if any - in the S&P will central banks step in?

So far, there have been no clues or hints as to the answer. Worse, actual statements by central bankers have been decidedly non-interventionist: last week, as investors finally woke up to the likelihood that central bankers are serious about pulling back stimulus this year to control inflation, Bank of England Governor Mark Carney declared on Thursday that he may even need to raise interest rates faster than previously thought.

“There will be ups and downs in financial markets,” Carney told reporters in London. “What’s happened in volatility markets is not an entirely surprising development.”

Adding to the rate volatility - and equity selloff - the BOE effectively put investors on alert for another increase perhaps as soon as May by lifting its forecasts for economic growth and saying inflation will remain above its 2 percent target. "It will be likely to be necessary to raise interest rates to a limited degree in a gradual process, but somewhat earlier and to a somewhat greater extent than what we had thought in November. Domestic inflationary pressures are likely to firm", Dudley said.

This sentiment was echoed in Europe, where ECB speakers also brushed aside the sell-off by continuing to debate how to end their bond-buying program, which is currently set to run until September. "Policy makers should not allow ourselves to become unsettled by the decline in equity prices we have just witnessed,” Bundesbank President Jens Weidmann said in Frankfurt.

The ECB continues to pump tens of billions of liquidity into the euro area, creating the false impression of an economic recovery even as it distorts asset prices around the globe to an unprecedented degree. Yet Weidmann said in his speech that “if the expansion progresses as currently expected, substantial net purchases beyond the announced amount do not seem to be required.”

* * *

But most concerning of all were statement made by Fed officials, such as ex-Goldmanites Bill Dudley and Robert Kaplan, both of whom poured cold water on any expectation of an imminent intervention:

“More volatility in the markets, and maybe addressing some of the excesses and imbalances in the markets, by having a little more volatility, may be a healthy thing,” Dallas Fed President Robert Kaplan told Bloomberg TV on Thursday.

One day later, Philly Fed president Patrick Harker said equity volatility makes sense based on yields, effectively capping stocks as long as yields keep rising, in the process pushing up volatility.

Finally, outgoing NY Fed president Bill Dudley completed the trifecta stating that he is not at all worried the recent market drop will have an impact on the economy.

Meanwhile, despite Friday's afternoon's miraculous bounce, the mood remains gloomy. For UBS Group AG Chairman Axel Weber, a former ECB policy maker, that’s nothing to fear. "The market has shown an unprecedented level of complacency,” he told Bloomberg Television. “A correction was waiting to happen."

The bigger question is when does the correction become a crash. Because if so far it has been the expectation that central banks will step in any minute now which has prevented the equity rout from going systemic, a few more days of silence by central banks, and last week's sharp selloff will seem like a dress rehearsal to the 10 years of pent-up mean reversion that may slam global capital markets as normalization finally kicks in.

Comments

BullyBearish waterwitch Sat, 02/10/2018 - 10:41 Permalink

10% correction my A$$...it just gave up the rocket shot since November...less than a paper cut...

 

the only thing going up from here is the level of distraction from the global economy...thereby the increased us military budget, the increased saber rattling, the increased incursions looking to start conflicts...

In reply to by waterwitch

TheWholeYearInn dead hobo Sat, 02/10/2018 - 14:00 Permalink

"But most concerning of all were statement made by Fed officials, such as ex-Goldmanites Bill Dudley and Robert Kaplan, both of whom poured cold water on any expectation of an imminent intervention:

“More volatility in the markets, and maybe addressing some of the excesses and imbalances in the markets, by having a little more volatility, may be a healthy thing,” Dallas Fed President Robert Kaplan told Bloomberg"

 

Translation:

"But most concerning of all were statement made by Fed officials, such as (((ex-Goldmanites Bill Dudley and Robert Kaplan))), both of whom poured cold water on any expectation of an imminent intervention [now that Yellen is gone]:

“More volatility in the markets, and maybe addressing some of the excesses and imbalances in the markets [that (((Greenspan, Bernanke, & Yellen deliberately caused)))], by having a little more volatility, may be a healthy thing,” Dallas Fed President (((Robert Kaplan))) told (((Bloomberg)))"

 

IOW ~ (((Goldman))) is BALLS DEEP 'short' right now, &, since the Trump cabinet is full of (((Goldmanites))), this is the way things are... Have fun catching falling knives, but don't worry, when it's reached MAX PAIN, we'll step in and SAVE the DAY again.

 

Same as it ever was. Great gosh a' mighty this country is fucked!

In reply to by dead hobo

hongdo NickyGall Sat, 02/10/2018 - 11:49 Permalink

I used to think we lived in an economic thermodynamic whirlpool where the rules of entropy are suspended due to the large economic flows.  I now think that large eddy currents in economic thermodynamics generate synthetic local environments that can assume any form temporarily.  However, collapse and return to the stern order of entropy is unavoidable when the flow across the discontinuity powering the environment stops.

So to respond to your observation that " We are living in an unsustainable economic reality." You are correct.

In reply to by NickyGall

Paul John Smith Sat, 02/10/2018 - 10:35 Permalink

"Show us where reality touched you ... BoA ... show us what the bad man did ... what caused your critical stress signal ..."

Jesus ... Jooz complain when they bomb the fuck out of people AND EVENTUALLY those people fight back ... now the JOOZ are "hurting" and the central bank will step in ...

I wonder, sometimes, if there is a God ... is he laughing, or crying?

EternalAnusocracy Paul John Smith Sat, 02/10/2018 - 11:38 Permalink

There is no "God" in the Abrahamic religion sense.  The Schtizo raving lunatic spawned three violent "religions" and now the world may finally end due to the mental disease known as the Abrahamic religions.  

Bring back the Norse gods of the North, the Old Believers of Rus, Avesta believers of the middle east, and all the other polytheistic believers of old.  Bring back the cults of Mithra, the mysteries of Dionysis, the legends of Zeus and the tales of gods of the New World.  

The mental disease known as the Abrahamic religions should be left in the dust bin of history;  excise this tumor from humanity's future.   Our descendents will thank us.

In reply to by Paul John Smith

chestergimli EternalAnusocracy Sat, 02/10/2018 - 14:28 Permalink

Excuse me, Buddy.  But Jesus told the posterity of Abraham that their father was the devil.  Reading some of the things of the Old Testament, I believe this to be true, including Abraham or Abram.

 

He couldn’t just walk in and tell the little Jewish people whom he wanted to save that Abraham, whom they had been taught to revere, was a wicked man and the son of the devil anymore than Our Blessed Lady of Fatima could have told the children of Fatima that the problem lay with the Jews.  They would have been kidnapped and killed and that would have been the end of Fatima.

 

Our Lord, Jesus Christ had nothing in that Jewish religion.  However, he needed to follow the narrative in order to get his messge across. 

In reply to by EternalAnusocracy

EternalAnusocracy chestergimli Sun, 02/11/2018 - 21:09 Permalink

but what do you say to the followers of the Gods of the Norse, and the Gods of the Rus.  When the desert religions got into Europe, they destroyed the indigenous religions and beliefs.

 

Must be something in the European genes.... destined to first lose their culture to the desert religion and now to lose their land to he Islamics.  Middle East is the bane of Europe.  Charles Martel must be rolling in his grave.

In reply to by chestergimli

Ajax-1 Arnold Sat, 02/10/2018 - 11:10 Permalink

I recently decided to be an Organ and Tissue donor. However, for now all I can afford is a box of Kleenex. Badabing Badaboom. Thank you ladies and germs, I'll be performing nightly in the Velvet Room at the Ramada Inn by the airport. Be sure and tip your waitresses, they are working hard for you.

In reply to by Arnold

Bernard_2011 Sat, 02/10/2018 - 10:40 Permalink

Now that Trump is President, it looks like the central bankers have decided to remove the "market put".  

 

They'd probably like to see the stock market and economy tank before the 2018 mid-term elections, so that hopefully the Democrats will take back control of Congress and then proceed immediately to the impeachment of President Trump---which is the end goal.

Ajax-1 Bernard_2011 Sat, 02/10/2018 - 11:13 Permalink

Yep, you nailed it. However, a month ago I predicted that they would continue to support the "melt-up" until May-June, 2018. I was wrong, they started shearing the sheep to sabotage Trump earlier than I thought. I can only assume that it was prompted as retaliation and a diversion for the FISA memo release. The timing was way too suspicious for me to believe it was a coincidence.

In reply to by Bernard_2011

Bernard_2011 Sat, 02/10/2018 - 10:45 Permalink

The global central bankers had "Obama's back" for 8 years straight with balance sheet expansion.  

 

Now that Trump is President---it's time to start contracting the balance sheets.  Surely it's just a coincidence....

MrNoItAll Bernard_2011 Sat, 02/10/2018 - 11:07 Permalink

Who happens to be POTUS at any given point in time is probably irrelevant. They are all just puppets at this point in history, subservient to much greater powers (BIG MONEY) that really run the show. The plan to crash the economy has been proceeding on schedule for a long time, spanning at least 3 - 4 different presidents. Don't get wrapped up in us versus them politics is my advice -- to do so is simply playing into hands of those who seek to control us by setting us against each other over trivial, hot button emotional issues in a "divide and conquer" kind of way.

In reply to by Bernard_2011

buzzsaw99 Sat, 02/10/2018 - 10:45 Permalink

they absolutely will change course.  everybody knows it.  $1T in QT, yeah, right.  i will eat my own dick, er, scratch that, but rather hat, if the fed sells $1T and raises rates three more times.  NFW!

MrNoItAll buzzsaw99 Sat, 02/10/2018 - 11:12 Permalink

Unless of course TPTB have decided that now is the time to finally let this global economy crash back to some semblance of reality. We all know it has to happen sooner or later. Somebody at the FED in elite power circles must also recognize that same fact. They've done a remarkable job of keeping this zombie economy going for as long as they have. But who's to say that the decision hasn't been made to finally let this sucker go down. I guess we'll find out soon enough.

In reply to by buzzsaw99

vegan Sat, 02/10/2018 - 10:51 Permalink

Trump is sitting in the White-house, so I'm inclined to think that the  bump on Friday afternoon is just a bull-trap. The shadow players need to have a big crash and blame it on Trump.

What are your top picks for equities to short? And why?

Alexander De Large Sat, 02/10/2018 - 11:16 Permalink

I applaud Bank of America for having the honorable courage and bravery to call for the Fed to step in during this brief buying opportunity disguised as a dip.

Do not worry, my banking friends, the Federal Reserve is already ahead of you, and have been stepping in for years.

One of the uniquely American things about America that makes us moar freer and democratic than every group of people in the history of time and space, is the courage to act possessed by our central bankers.  It is common knowledge that banking regulations are Communist tools to control Wite people.

Hopefully, this current buying opportunity in stocks will get the ball rolling on those NY Fed Trading Desk television ads, so my son Theodore Donuld J. Trump Bundy, can one day aspire to be a stock broker working directly for a Federal Reserve bank.  

Ted is only 3 years old, but the way he draws pictures on paper then uses them as a medium of exchange to purchase goods and services from me and my wife, I know he was born to trade equities for the Fed.

 

moneybots Sat, 02/10/2018 - 11:38 Permalink

"The bigger question is when does the correction become a crash."

 

The correction was a crash. The chart above shows a 10%+ drop, practically straight down.